Sunday, October 30, 2016

NCBJ Report 2016: Restructuring and Bankruptcy Challenges in the 21st Century World of Not for Profits

This was the first of two educational programs sponsored by the Commercial Law League of America.   I had the privilege of appearing on a panel featuring moderator Beverly Weiss Manne, Prof.  Pam Foohey, Sam Maizel and Nancy Peterman.   Prof. Foohey and I focused on religious entities in bankruptcy, while Sam Maizel and Nancy Peterman discussed healthcare non-profits.   

Types of Cases Filed

On the church side, Prof. Foohey's research shows that 654 churches filed bankruptcy between 2006 and 2013.   The vast majority of these churches were African American congregations.    Some of the notable filings during 2016 included Carter Tabernacle Christian Methodist Episcopal Church, a 100 year old congregation in Orlando and Metropolitan Baptist Church in the District of Columbia.    Since 2004, fifteen Catholic Dioceses and religious orders have sought chapter 11 protection to resolve sexual abuse claims.   Two examples of these cases are the Diocese of Stockton which is proceeding toward a consensual confirmation following a two year mediation process and the Diocese of St. Paul and Minneapolis, MN where competing plans have been proposed by the Diocese and the Committee of Unsecured Creditors.    Finally, a handful of predominantly white mega-churches, such as the Crystal Cathedral and Great Hills Baptist Church have entered chapter 11 proceedings.   On the healthcare side, there have been at least nine hospital bankruptcies filed this year.   However, healthcare filings range from community hospitals to skilled nursing facilities.    In re Bayou Shores, SNF, LLC, 828 F.3d 1297 (11th Cir. 2016) is an example of the issues that can arise in the healthcare sector.

Operating Structure

The different types of religious and healthcare entities pose challenges in dealing with corporate governance.   Community hospitals frequently have a board composed of volunteers with a passion for the mission of the entity but with little business experience.   African American congregations may have a nominal board of elders, but the pastor generally manages the church. Indeed, the board may not even be aware of the filing.  In Roman Catholic dioceses a bishop or archbishop appointed by the Vatican holds sole authority.   White mega-churches often have an active board of lay members although the pastor is a highly influential actor.   Both Catholic Diocese and mega-church bankruptcies tend to be very public.     

Debt Structure and Funding

Debt structure and funding vary between the different types of non-profits.   Small African American churches rely almost entirely on parishioner donations or business income such as operating a day care.  However, Prof. Foohey pointed out that the business operations may lose money and contribute to the financial problems of the church.    Mega-churches rely heavily on tithes but may also have ancillary business income such as sale of books and DVDs.     Among both types of churches, the primary creditor is the secured lender on the church property.   Sometimes there are specialized lenders that finance churches such as the Evangelical Christian Credit Union.    Because contributions are often not covered by the lender's security interest, cash collateral is usually not a factor.

The Roman Catholic dioceses and orders have a much different funding and debt structure. This round of bankruptcies have been generated by overwhelming waves of sexual abuse tort claims which threaten both the financial stability of the Diocese and its moral standing.    A Catholic diocese generally receives contributions from parishes within the diocese to fund ongoing operations.  Tort claims may be covered by insurance although there are often coverage disputes.    Attempts to claw back assets that were once owned by the Diocese are a common feature of Diocese bankruptcies.   For example, in the Diocese of Milwaukee case, the Debtor transferred funds into a cemetery trust fund prior to bankruptcy.

The Diocese of Stockton case provides a good example of how plans are funded.   In that case, the Diocese agreed to pay $14.25 million into a trust for tort claimants.   Of this amount, the Diocese contributed $9.9 million from available cash and sale of assets, the insurers contributed $3.3 million and other Catholic entities contributed $3.9 million.    The parishes and schools contributing to the settlement received a release of potential claw-back liability as well as from claims related to priests or other religious who committed abuse while in the specific parish or school.     

In the healthcare space, tax exempt bonds and government payments from Medicaid and Medicare are significant sources of revenue.   Cases are often precipitated by the government's decision to withhold payments based on an overpayment.   Because the government holds back funds under the doctrine of recoupment, the automatic stay does not apply to prevent the government's self-help remedy.   In addition to the government, creditors include secured lenders, doctors and tort claimants.

Unique Aspects

Healthcare bankruptcies have several unique features.   First, there is usually a patient care ombudsman appointed which adds a layer of expense.   Additionally, state attorneys general are likely to be active players to ensure that health and safety standards are maintained.   Keeping doctors and dealing with a volunteer board are other challenges.    In the case of a sale, continuing the mission of the non-profit is a relevant factor in addition to obtaining top dollar.  Sam Maizel gave an example of a case where the Debtor accepted a slightly lower offer that would further the mission of the non-profit over a higher offer that did not.    When a facility is sold, there must be provision made for preservation of patient records.   In the unusual event of a surplus, the remaining funds must go to a qualified non-profit.

 For smaller churches, proving feasibility is particularly challenging since member contributions are likely to fall off when the church is in financial difficulty.    In the Catholic Diocese cases, the Debtor must deal with claims that may have arisen decades earlier and are emotionally charged while reassuring parishioners that their places of worship will not be drawn into the bankruptcy of the Diocese.

Both types of non-profits are exempt from being placed into involuntary bankruptcy by 11 U.S.C. Sec. 303(a).    This played an important role in the Diocese of St. Paul and Minneapolis case.   The Official Creditors' Committee sought to substantively consolidate the Diocese with two hundred non-bankrupt parishes and schools.    In denying the motion, one of the grounds that the Court gave was that substantive consolidation would involuntarily bring the non-bankrupt entities into bankruptcy in violation of section 303(a).

11 U.S.C. Sec. 541(b)(1) may also play a role in a non-profit bankruptcy.   It says that a "power that the debtor may exercise solely for the benefit of another" is not property of the estate.   In the Baptist Foundation of Arizona case, the Foundation had the right to name the boards of numerous other non-profit entities.   When the Board of one entity balked at being dragged into the bankruptcy, the Debtor sought to replace the Board with a more compliant one.   The Court ruled that the right to name the Board was a "power exercised for the benefit of another" and could not be exercised by the Debtor.

However, religious entities generally do not receive any special protection under either the Free Exercise Clause of the First Amendment or the Religious Freedom Restoration Act (RFRA).   In Listecki v. Official Committee of Unsecured Creditors, 780 F.3d 731 (7th Cir. 2015), the Seventh Circuit held that RFRA did not preclude a suit by the Creditors Committee to recover money transferred to a cemetery trust fund.   The Court found that in order for RFRA to apply, a government actor would have to burden the free exercise of religion without a compelling governmental interest.   The Court found that the Official Committee of Unsecured Creditors was not a governmental actor and  that the protection of creditors was a compelling governmental interest.

The Courts have also rejected challenges that the application of bankruptcy law substantially burdened the Free Exercise of religion under the First Amendment.   In In re Congregation Birchos Yosef, 535 B.R. 629 (Bankr. S.D. N.Y. 2015), parties who had been sued  in an adversary proceeding sought to invoke a Jewish religious proceeding instead.   The Court found that the attempt to force the Debtor to adjudicate the dispute outside of bankruptcy under threat of being shunned violated the automatic stay and that the stay did not violate the First Amendment rights of the defendants.

However, courts cannot adjudicate matters that would require interpretation of church doctrine.  In two of the Catholic Diocese cases, priests accused of sexual abuse filed proofs of claim after they were dismissed following a trial under canon law.   Both of the Courts found that under the ecclesiastical exception, the Court did not have jurisdiction over the dispute.

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